This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.

IMF Cuts Global Outlook

Fund also warns that a U.S. government default could ‘seriously damage’ world economy.

The International Monetary Fund cut its global outlook for this year and next as capital outflows further weaken emerging markets and warned that a U.S. government default could “seriously damage” the world economy.

Growth worldwide will be 2.9 percent this year and 3.6 percent next year, the IMF said in a report released today in Washington, compared with July predictions of 3.1 percent for 2013 and 3.8 percent for 2014. It sees emerging economies growing 4.5 percent this year, 0.5 percentage point less than three months ago, as projections were reduced for China, Mexico, India and Russia.

“Advanced economies are gradually strengthening” while “growth in emerging-market economies has slowed,” IMF chief economist Olivier Blanchard wrote in a foreword to the World Economic Outlook report. “This confluence is leading to tensions, with emerging-market economies facing the dual challenges of slowing growth and tighter global financial conditions.”

The IMF’s forecasts factor in a short U.S. government shutdown and an agreement on the nation’s debt-limit before an Oct. 17 deadline. A stalemate that causes a default “could seriously damage the global economy,” the fund said.

President Barack Obama reiterated yesterday that he won’t negotiate with Republicans over the partial shutdown and the U.S. debt limit as Senate Democrats began preparing for a test vote on a clean debt-ceiling bill. Many U.S. government services have been shuttered for more than a week and the country is nine days away from running out of its ability to stay under a $16.7 trillion cap on borrowing.

“A longer shutdown could have sizable adverse growth implications,” the IMF said in the report. “A failure to promptly raise the debt ceiling could also adversely affect financial markets and economic activity, with spillovers to the rest of the world.”

With Europe overcoming its debt crisis and a recovery of the U.S. housing market, global policy makers’ concerns are shifting to the uncharted territory of exiting extraordinary monetary stimulus. Bond prices slumped internationally and emerging-market stocks plunged after May 22, when Federal Reserve Chairman Ben S. Bernanke said for the first time the Fed may trim its asset-purchase program within the next few meetings.

While those markets rebounded last month after the central bank refrained from paring its bond buying plans, the IMF said developing economies’ sovereign yields are now 0.8 percentage point higher than at the beginning of the year.

Clear Communication

“This change could pose risks for emerging-market economies, where activity is slowing and asset quality weakening,” the IMF wrote in the report. “Careful policy implementation and clear communication on the part of the Federal Reserve will be essential.”

The fund said its forecasts assume the Fed won’t raise its benchmark interest rate, which has been near zero since December 2008, before 2016 and that the U.S. central bank will start tapering its bond-buying program later this year.

The IMF urged the world’s major economies to adopt policies that will boost their prospects or face prolonged subdued expansion, especially at a time of weaker growth in China, which will hurt commodities exporters and other developing economies.

The U.S. needs better fiscal plans for the medium term, and the economic drag from across-the-board, automatic budget cuts this year may be bigger than the fund expected, according to the report. The IMF cut its growth forecast for the world’s largest economy to 1.6 percent this year and 2.6 percent next year, each 0.1 percentage point less than forecast in July.

Japan, where the IMF maintained forecasts of 2 percent growth this year and 1.2 percent next year, also needs a strong budget plan for coming years, according to the fund. While the current fiscal and monetary stimulus is proving effective, the central bank should be prepared for another round of monetary stimulus if it doesn’t manage to boost inflation expectations to its target of 2 percent, according to the fund.

The IMF raised its forecast for the 17-country euro area to a contraction of 0.4 percent this year compared with a 0.6 percent decline in July. It now expects an expansion of 1 percent next year instead of 0.9 percent three months ago. While Italy and Spain are expected to shrink this year, Spain’s forecast contraction of 1.3 percent is an improvement from a 1.6 percent prediction three months ago.

Still, the region’s financial industry remains fragile and next year’s planned assessment of the banks’ balance sheets by the European Central Bank “provides a critical opportunity to put the system on a sounder footing,” the IMF said.

ECB’s Policy

The euro-area’s central bank should also consider giving additional monetary support through lower interest rates, forward guidance on future rates or negative deposit rates, it said.

The prospect of higher U.S. long-term interest rates and a partial reversal of capital flows is leaving emerging markets with weak fiscal positions or higher inflation particularly exposed, the fund said.

“First, where needed, countries must put their macro houses in order by clarifying their monetary policy framework and maintaining fiscal sustainability,” Blanchard wrote. “Second, they must let the exchange-rate depreciate in response to outflows.”

The fund cut the forecast for China to 7.6 percent this year, from 7.8 percent in July and to 7.3 percent in 2014 from 7.7 percent.

“Without fundamental reform to rebalance the economy toward consumption and stimulate productivity growth through deregulation, growth is likely to slow considerably,” the fund said of the world’s second-largest economy.

Russia’s growth model also seems “exhausted,” according to the report, which sees growth at 1.5 percent this year instead of 2.5 percent in July and 3 percent next year, from 3.3 percent.

India will grow 3.8 percent this year, down from a July prediction of 5.6 percent, and 5.1 percent in 2014, from 6.3 percent. Mexico will expand 1.2 percent this year from 2.9 percent in July, and its outlook was cut to 3 percent next year from 3.2 percent.

Treasury & Risk

Treasury & Risk is an online publication and robust website designed to meet the information needs of finance, treasury, and risk management professionals. Our editorial content, delivered through multiple interactive channels, mixes strategic insights from thought leaders with in-depth analysis of best practices, original research projects, and case studies with corporate innovators.